Treasury bonds sit at the centre of the financial system, yet many beginners find them confusing. Prices move, yields move in the opposite direction, and the vocabulary can feel like a foreign language. This guide explains how treasury bonds and other fixed income investments work in plain English, so you can read market headlines with more confidence and understand what you are actually buying.
What is a treasury bond?
A treasury bond is a loan you make to a national government. In return, the government promises to pay you interest at regular intervals and to give your original money back on a set date. That interest is called the coupon, the original amount is the face value or principal, and the end date is maturity.
Because the payments are fixed in advance, bonds are grouped under the label “fixed income”. Fixed does not mean risk-free, though, and it does not mean your total return is guaranteed if you sell early. It simply means the schedule of payments is set when the bond is issued.
Bills, notes and bonds
In the United States, government debt is usually described by how long it lasts:
- Treasury bills mature in a year or less and typically do not pay a regular coupon. They are sold at a discount and repaid at face value.
- Treasury notes run for a few years up to ten and pay interest twice a year.
- Treasury bonds are the longest, with maturities of twenty years or more, and also pay interest twice a year.
Other countries use different names and features, and some governments also issue bonds linked to inflation. Always check the rules that apply where you live, because tax treatment and product details differ.
Price, coupon and yield
Three ideas explain most of what you will read about bonds.
The coupon is the fixed interest payment set at issue. The price is what the bond costs in the market today, which can be above or below face value. The yield is the return you would earn if you bought at today’s price and held to maturity, taking both the coupon and any gain or loss on price into account.
When investors want a bond more, its price rises and its yield falls. When they want it less, the price falls and the yield rises. That inverse relationship is the single most important thing to remember. If you want to see why yields shift so often, read our guide to how interest rates affect your investments.
A simple example
Imagine a government issues a bond with a face value of 1,000 and a coupon of 4 percent. It pays 40 a year until maturity. Now suppose new bonds are issued paying 5 percent. Nobody wants your 4 percent bond at full price when a 5 percent alternative exists, so its market price has to fall until the overall return looks competitive. If you hold to maturity, you still receive every coupon and the full 1,000 back, assuming the issuer pays. If you sell early, you take whatever the market offers.
The numbers are round and purely illustrative.
Why investors buy government bonds
People hold treasuries for several reasons:
- Predictable income. Coupons arrive on a known schedule.
- Lower default risk. Governments that borrow in their own currency are generally seen as more reliable borrowers than most companies, although no borrower is perfect.
- Diversification. Bonds and shares often behave differently, which can smooth the ride in a portfolio, though not always.
The main risks
Bonds carry their own risks.
Interest rate risk. When rates rise, existing bond prices fall. The longer the maturity, the bigger the effect. A long-dated bond can lose noticeable market value if rates climb.
Inflation risk. Fixed payments buy less if prices rise faster than expected. Inflation-linked bonds try to address this, but they have their own quirks.
Reinvestment risk. When a bond matures, you may only be able to reinvest at lower rates.
Credit and currency risk. Governments can and do run into trouble, and if you buy bonds issued in a foreign currency, exchange rates affect your result.
Ways to hold bonds
You can buy individual bonds directly from a government auction or through a broker. You can also use bond funds or exchange-traded funds, which hold many bonds at once. Individual bonds have a maturity date, so you know when you get your principal back. Funds do not mature, so their value keeps fluctuating with market yields. Funds also charge ongoing fees, so compare costs. Our overview of how to compare investment platforms covers what to look for in fees and product range.
Questions to ask before buying
- What is the maturity, and can I cope if the price falls before then?
- What is the yield to maturity, not just the coupon?
- How is interest taxed where I live?
- Am I buying an individual bond or a fund, and what does it cost?
- Does this fit my time horizon and my other investments?
Where bonds fit for beginners
If you are new to investing, you do not need to master bonds on day one. Many people begin with a diversified fund and learn as they go. Our beginner’s guide to starting to invest walks through the basics of goals, time horizon and risk.
The takeaway
Treasury bonds are loans to governments that pay fixed interest and return principal at maturity. Their prices move opposite to yields, and they carry interest rate, inflation and reinvestment risks. Understanding those trade-offs is far more useful than chasing a headline yield.
This article is general information only and not financial advice. Investments can fall as well as rise, and nothing here recommends a specific product. Consider speaking with a qualified professional about your circumstances.